Investment statements increasingly confusing

By BRENT SHEATHER

If you are one of the hundreds of thousands of New Zealanders who entrust their savings to managed funds, the chances are that, before parting with your hard-earned cash, you consulted your fund's investment statement.

Since 1997 the investment statement - as opposed to the longer, more detailed prospectus - has been the document that most people rely on when investing in managed funds. As such, investment statements are perhaps second only to investment advisers in influencing decisions.

But are such statements really doing the job for which they were designed?

The many investors who apparently withdraw from these supposedly longterm investments after a relatively short period suggests that the information provided could be improved so that investors' expectations are more representative of the likely outcomes.

Furthermore, in the United States and Britain the key issues - returns, risks and fees - are set out in more detail than in New Zealand, and with greater clarity.

The form on the US Securities and Exchange Commission (SEC) website which prescribes what should be in a mutual fund prospectus in the US runs to 56 pages and makes the use of plain English mandatory.

The objective of the investment statement is to provide prudent but non-expert investors with key information about the investment so they can more readily understand it, compare different products and make an informed decision.

These documents should be simple and straightforward.

The requirement for simple, succinct and understandable information makes sense in the light of overseas experience.

Surveys in the US and Britain suggest that very few investors read detailed prospectuses.

Of those who do, only a small majority understand or can interpret the information in a meaningful way.

In New Zealand, the investment statement was designed to be a more user-friendly replacement for a prospectus.

A study of the effectiveness of investment statements by the local Securities Commission in 1999 queried the quality of answers to the following questions:

* What are my charges?

* What returns will I get?

* What are my risks?

These three key areas are critical to making an informed investment decision and, unsurprisingly, are exactly the same areas where US and British regulators have emphasised the need for extra effort.

Analysis of the investment statements from a group of New Zealand's largest fund managers suggests things have not improved markedly in the last two years; in the 'What are the charges' section of the statement for a popular mastertrust, eight different fees are mentioned but many are not quantified and nowhere is the total annual fee calculated.

This is clearly unsatisfactory; the mastertrust manager should provide an estimated management expense ratio for a typical portfolio then compare this with the expected longterm return of this sort of balanced portfolio.

The singularly unhelpful mastertrust investment statement simply points out that the higher the fees, the lower the return. Brilliant.

The 'What returns will I get' section of the statements reviewed were similarly unimaginative. Many just pointed out the obvious: that returns will be due to the investment portfolio's performance (unquantified), less fees (unquantified) and taxes (unquantified).

But this is a relatively simple exercise to do properly: we know what the average pension fund or balanced unit trust looks like, we know the performance of the component parts over a suitably long period (20 years or so), we know the average management expense ratio and we know the tax rate. Three examples could be given, using actual data, for three portfolios: balanced, all shares and all bonds.

One can only speculate why no fund manager has done this, although the fact that taxes and fees will probably consume half the returns of a balanced portfolio in a normal year probably gives us a clue.

Using their websites, managers could permit users to integrate their website savings calculators with the actual return, cost and tax numbers relevant to their unit trusts. Few, if any, do this.

Much more effort has been put into the 'What are my risks' section, but most of the discussion was quite technical and short on actual numbers.

It would have been helpful to see some statistics along the following lines: shares average one negative year in four, whereas for bonds it is one in 10.

In the US, fund managers typically use this section to describe the types of investor for which the fund is intended, and advising details of the highest and lowest quarterly return over 10 years is mandatory.

At least most managed funds produce an investment statement. Some investment mediums don't.

Unfortunately for the local savings industry, the benchmark for comparison is not the ostrich farms and various other get-rich-quick schemes that are not required to furnish a statement.

Increasingly, New Zealand fund managers must compete with the most enlightened regulatory regimes in the world.

With the advent of the internet local investors can enjoy the rules and regulations protecting US or Australian investors.

One needs only to look at the latest prospectus for the US-based Vanguard or Fidelity products to see the extent to which we are being short-changed locally.

And US authorities are not even happy with the status quo. In a speech to the Investment Company Institute, retired SEC chairman Arthur Leavitt called on fund managers to redouble their efforts to set out clearly and in plain English everything a prospective investor needs to know to make an informed decision, particularly as regards fees.

"You've got to do a better job of making sure that those who sell funds also explain the costs of investing," he said.

"Our research shows that less than half of mutual fund investors know that fund expenses are deducted on an ongoing basis. Only 8 per cent say they completely understand the expense that their funds charge.

"We can only guess whether they actually do. Financial illiteracy is very troubling in an era when workers are shouldering a significant portion of their retirement planning."

What on Earth would Mr Leavitt have to say if he addressed the New Zealand unit trust industry, whose disclosure requirements include understating their management expense ratios by one-third, under the guise of it being after-tax? My guess is he would use some colourful language.

The simple fact is that many kiwi institutions would be breaking the law if they tried to sell their unit trusts in the US without first upgrading their disclosure standards. We have all heard about the globalisation of investment but the globalisation of standards has yet to reach our shores.

Specific areas where New Zealand fund managers could learn from their US counterparts include:

* Fees and expenses, including pre-tax management expense ratios, must be summarised and set out in an easily readable form within the first few pages of the prospectus, with an example of what your portfolio would be worth assuming a gross 5 per cent return for five years, the deduction of standard initial and annual operating costs and redemption fees.

The choice of a 5 per cent return is critical; some New Zealand masterfunds have total fees approaching this level. Total costs paid must also be disclosed, assuming $10,000 is invested.

* A table and bar chart must be included in the prospectus showing the fund's performance over one, five and 10 years and the performance of an appropriate broad-based index.

If the fund is sold with a brokerage fee the document must state this and say these charges are not reflected in the bar chart, and that actual returns would be less.

* Portfolio turnover must be detailed in the prospectus for each of the last five years, with comments.

* The names and addresses of the principal unit-holders must be given, with their percentage holdings.

* The prospectus must state the percentage of the fund that is owned by all officers, directors and members of the fund's advisory groups.

The SEC's rulings on clear, plain-English summaries of costs have particular relevance to the burgeoning mastertrust industry in New Zealand, where typically multiple layers of fees are referred to throughout the investment statement but rarely summarised in a readable form for a novice investor.

With returns from all types of investments falling to single digits, fees are going to come under more scrutiny.

Similarly, it is the fund manager's job to properly manage expectations - focusing on the fact that this fund or that fund has achieved a 30 per cent return in the last year is irresponsible at best.

Indeed, the chief regulatory body in Britain, the Financial Services Authority, has hinted that it may ban such advertising.

Local fund managers should look at best practice overseas and lift their game to give consumers what they need, instead of just lobbying the Government to make longterm savings compulsory.

* Brent Sheather is a Whakatane sharebroker and investment adviser.